Sources of Capital

for Entrepreneurial Venture

Lecturer: Ph.D Li, Fangxi

Econometrics & Business Accounting

Institute of International Education, Liaoning University

Objectives

1.To be able to distinguish the five forms of entrepreneurial

capital

2.To understand sources of capital

3.To differentiate between debt and equity as methods of

financing

4.To discuss several types of equity capital

New Ventures Need Money

1. what do you plan to do with the money?

2. How much do you need?

3. when do your need it?

4. How long will you need it?

– Choose the right source

–Know the right people to get money

–Plan money into your timeframe

–Be creative where it counts

–Know what you’re getting into

Capitalwhat is Capital?

• Capital is any resource (human-made or natural ) that is used to create other goods or services. We also call them all factors of production.

• E.g. Financial capital, human capital, etc.

Why do we need to know these?

• What types of capital to use and when

• Attempt to find appropriate start-up capital

• Exanimate the sources of capital available to entrepreneurs.

Five Forms of Entrepreneurial Capital

Financial capital:

Financial assets, such as

currency, bank accounts,

bonds and stock :

Manufacturing capital

physical goods, such as

machinery，roads, boats,

factories

Human capital:

peoples’ health, knowledge, skills

that people bring to their jobs.

Social capital

the value of a person’s network.

Natural capital

stock of natural ecosystems

land, water, and minerals.

Debt Versus Equity

• Equity Financing

It involves the sale of some of

the ownership in the venture

–The personal investment of an

owner in a business

–Entrepreneur gives control to

other owners

• Debt Financing

The use of debt to finance a new

venture involves a payback of

the funds plus interest for using

the money.

–Financing that is borrowed and

must be repaid

– Includes an interest component

Debt Versus Equity

• Equity Financing

Advantages：

1. A large injection of capital

2. No interest payments

3. No obligation to repay capital

Disadvantages:

1. degree of control reduced

2. Selling a part of your business

3. High return is expected

4. Buy your share at a future point

• Debt Financing

Advantages：

1. Amount borrowed can vary

according to your needs

2. not affect your ownership of the

company

Disadvantages:

1. Debt obligation

2. Interest will be charged

3. Collateral is usually required

Debt Financing

• Commercial Banks - loanAgain, you do have to repay loans, with interest.

• Other Debt-Financing–Trade Credit

–Accounts Receivable Financing

–Finance Companies

Commercial Bank – Loan

Traditional financing tunnel

most common source

May turn you down because you have no collateral, no cash flow

plan, or you haven’t provided them with convincing information.

Risk Management System: risk test and credit test

Big companies (AAA credit level ): lower interest rate

Big companies (below AA- credit level )-Third party guarantee or

Asset mortgage

Small or initial business -Personal Assets as mortgage

Other Debt-Financing Sources

Trade Credit

Given by supplier who sell goods on account

Account receivable financing

Account receivables as collateral for a loan

Finance companies

Asset-based lenders that lend money against assets. E.g.

receivables, inventory and equipment

Equity Financing for entrepreneurs

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Seed Start-Up EarlyGrowth

Established

Founder, friends,and family

Business Angels

Venture Capitalists

Private placement

Crowd funding

public offering

Stage of Development of the Entrepreneurial Firm

1. Informal Inventor

The source of financing for most start-ups; includes investments from (4Fs)

founders, their family, friends and foolhardy investors

rarest source of capital for start-up entrepreneurs is classic venture capital

India has an astounding rate of informal investing. China and New Zealand

also have a lot of informal investors.

How to get money from 4Fs

• Know your investor’s intentions

• Debt is better than equity for relatives and friends

• Have a realistic repayment or cash-out plan

• Prepare some documentation so that there is no misunderstanding..

2. “Angel” Financing• “business angels” (or informal risk capitalists). Many wealthy people in

the United States are looking for investment opportunities.

• One newly source is the Angel Capital Electronic Network (ACE-Net).

This Internet-based service provides information to institutional and

individual accredited investors

• Typical deal size: $250,000 to $5 million

• Typical recipient: Start-up firms

• Cash-out time frame: 5 to 7 years

• Expected return: 35 to 50%

Main Differences

• Personal

• Firms funded

• Due diligence done

• Location of investment

• Contract used

• Monitoring after investment

• Exiting the firm

• Rate of return

Business Angels

• Entrepreneurs

• Small, early-stage

• Minimal

• Of concern

• Simple

• Active, Hands-on

• Of lesser concern

• Of lesser concern

Venture Capitalists

• investors

• Large, mature

• Extensive

• Not important

• Comprehensive

• Strategic

• Highly important

• Highly important

Business Angels vs. Venture Capitalists

The Pros and Cons of Business Angel

Angels’ Characteristics

Value-addingGeographically dispersed

More permissive investors

Investment Characteristics

Seek Smaller DealsPrefer start-up & early stageInvest in all industry sectors

Like high-tech firms

Added Bonuses

Leveraging effectGive loan guarantees

No high fees

Advantages

Business Angels

Disadvantages

Littlefollow-on

money

Want a sayin firm

Could turnout to be“devils”

No nationalreputationto leverage

Types of Angel Investors

• Corporate Angels

• Entrepreneurial Angels

• Enthusiast Angles

• Micromanagement Angels

• Professional Angels

3. Venture capital

Venture capital (VC) is a form of financing that is

provided by firms or funds to small emerging

firms with high growth potential, or which have

demonstrated high growth.

They invest money, you give them shares.

they need participate in the board

Venture capitalists’ objectives : Be interested in

making a large return on investment (ROI). VC want to

work with a team with good credentials and experience

New-Venture Proposals

• critical factors for new-venture

proposals

(1) timing of entry,

(2) key success factor stability,

(3) competitive rivalry

(4)education capability,

(5) scope

(6) familiar with the market

(7) ROI

• Venture capitalists reached a go/no go

decision in an average of six minutes

• proposal should be complete, clear and

well presented. Venture capitalists will

generally analyse five major aspects

of the plan:

(1) the proposal size,

(2) financial projections,

(3) investment recovery,

(4) competitive advantage,

(5) company management.

Different Stages of Venture Capitalists

Stage of BusinessExpected Annual

Return on InvestmentExpected Increase on

Initial Investment

Seed financing(start-up stage)

60% 10-15 x investment

early-stage financing(new business)

40%-60%

early-stage financing(development stage)

30%-50%

Expansion financing(expansion stage)

25%-40%

Late- stage funding 50%

6-12 x investment

4-8 x investment

3-6 x investment

8-15 x investment

Venture capital internet resources

• Australian Venture Capital Association

• Global Entrepreneurship Monitor Financial

Reports

• Hong Kong Venture Capital Association

Ltd

• Singapore Venture Capital and Private

Equity Association

• http://www.avcal.com.au

• http://www.gemconsortium.

org

• http://www.hkvca.com.hk

• http://www.svca.org.sg

4. Crowd Funding

• Crowd funding is the practice of

funding a project by raising monetary

contributions from a large number of

people. New financial instrument.

• Successful case: Cartoon Movie

《Monkey King：Hero is back》

In 2015, 89 investors, contribute

￥7.8million to make the movie. they

earn 4 times of their initial investment.

Incentives Disincentives

Lower cost of capital Entrepreneur typically must disclose hispropritary idea to a larger public

There is a better match between entrepreneursand investors

Has engative repercussions on patentability

The entrepreneur has access to global funders Gives competitors inside information

The funder gains early access to the product andrecognition for helping innovation

Entrepreneur must(prematurely)disclose staffnames

More and better information increases thefunders' willingness

The crowd often has no special industryknowledge compared to professional funders

Crowdfunding is a good type of market research The crowd is atomised individuals not networks

Gives entrepreneurs valuable feedback on theirproject

Because there are more investor, there are moreinvestor management issues

Engages potential users in the product design Entrepreneur must deal with strongpersonalities

Crowd funding incentives and disincentives

Private Placements

• Private placement is money invested in a company usually from

private investors in the form of shares or sometimes bonds.

• In most cases, a placement agent (usually a share-broking firm

or investment bank) will manage the process for a fee.

• It looks for growth or expansion funding.

• Institutional investors such as banks, insurance companies,

venture capital firms.

Private Placements

Advantages

• a Company has considerable

control over terms of the

placement

• b Investors unlikely to want day-to-

day control

Disadvantages

• a Time consuming to prepare

detailed information for potential

investors

• b Cost of the placement to cover

fees of placement agent,

accountants, and lawyers

• c Level of disclosure required

Public Offerings

• many new ventures have sought capital through the

public markets.

• Initial public offering (IPO) is used to represent the

registered public offering of a company's securities for

the first time.

Public Offerings

Advantages of going public:

• Size of capital amount

• Liquidity

• Value

• Image

Disadvantages of going public:

• Costs

• Disclosure

• Requirements

• Shareholder pressure